The growth in consumer loans during July - March FY06 was quite robust at Rs. 67.2 billion

June 26 - July 02, 2006

The commercial banks in Pakistan earlier used to consecrate with almost all of their resources for providing financial assistance to 'productive sectors' of the economy like manufacturing, trade, agriculture and services with barely any of propensity or experience in advancing consumption loans except to their own employees against ironclad guarantees.

The unpredictable increase in consumption of loans, leading to strengthening of demand, has obviously the opposite effect. The striking consumption, which may partly be the result of consumer loans, may resulting in added social stress by making the rich-poor divide more glaring?

The trend of advancing consumer loans gained momentum only in the last few years with the expanded scale of consumer loans by 27 percent as compared to the corresponding period last year was soared up to Rs 67.2 billion during July-March, 2006.

The growth in consumer loans during July - March FY06 was quite robust at Rs. 67.2 billion, which used for acquiring finance a large range of products, including automobiles at Rs 23.2 billion, followed by personal loans of Rs 21.5 billion, credit cards for Rs 10.4 billion and Rs 10.1 billion for house financing. Consumer financing was being considered quite profitable for banks due to relatively higher spreads.

Such a sharp increase in credit for consumption purposes in such a short period of time is; of course, not advisable if the banks are not able to simultaneously develop systems, which could guarantee proper quality of assets and save them from recovery problems later on. There are already some complaints about non-recovery of loans advanced for purchasing cars and other durable.

There are also other compelling reasons to contain the growth of consumption loans within reasonable limits. In order to enhance the productivity of the economy, a higher percentage of our financial savings need to be diverted to the productive sectors to enable the country to reduce imports and expand its export potential.

On the other hand, the World Bank has advised the government to control liquidity in the banking system, as credit growth was witnessed in areas where banks were relatively inexperienced. The marked that "the increased liquidity in the system has led to a rapid expansion of credit to the consumer sector that could be problematic if corrective measures were not taken".

The World Bank has also suggested that the banks strengthen their credit appraisal since much of the credit growth was in areas where banks had little expertise. "There is also a need for close monitoring by the regulator to ensure that the rapid credit growth does not compromise credit quality and undermine the banks' balance sheets".

The irony of it is that free flow of credit to various sectors, particularly consumption loans, was indirectly the result of reform process undertaken in the financial sector with the assistance of the World Bank.

The advice of the World Bank that rapid expansion of credit to the consumer sector could, in future, become a problem for the banks, in our view, is quite valid. Also, the suggestion that the banks need to strengthen their credit appraisal mechanism and must not compromise the quality of their assets is beyond any question.

The example of other countries often given by our policy makers is not very appropriate due to the vast difference in the fundamentals of the economy and regulatory mechanism of the banks.

Developed countries often need to push up their consumption levels to increase capacity utilization and foster growth, while in Pakistan the foremost requirement is to boost saving and investment and increase installed capacity.

Economy of scale does matter for any industry to be competitive at the international level. At present, we are encouraging loaning for cars and motorcycles so that our engineering industry can grow to the point of becoming a world class exporter.

This diversification will reduce our dependence on textile sector for export earnings. However, for the financial system to grow, we need more financial instruments. Securitization of risk will reduce the banks' exposure. Derivatives are the tools most widely used for shifting the risk from banks' balance sheets to insurance companies.

This enables the banks to reduce their provisioning requirement and allows them to expand their advance portfolio. But for this is to happen issuance of long term government bonds with regularity is very essential.

Unfortunately, the present government has a myopic view of reduction in debt servicing cost. The debt management office of the government missed the boat when interest rates took a nosedive from 14 to two percent.

The Economic Survey claims that the national economy is undergoing structural shifts marked by rapid changes in consumer spending pattern. The real private consumption expenditure has more than just doubled from 8.2 percent to 16.8 percent, suggesting the emergence of a strong middle class with buying powers.

In fact, latest market reports suggest that consumer finance by banks has fuelled overspending with loan defaults surfacing as a result of recent interest rate hikes. Much of consumer spending has been encouraged by consumer financing (auto, housing, personal loans and credit cards), which accounts for Rs. 77 billion or 23 percent of the total private sector credit. Whether it is income or debt driven, only time will tell.

The big attraction in extending financial facilities to the passive consumer segment is the prospect of earning high interest rate spreads as consumers are soft targets as far as haggling over interest rates chargeable to them are concerned. They are much more likely to borrow at unrealistically high rates - a convenience that is no longer available on lending to industrial and commercial borrowers who now insist on the finest possible loan rates.

In pricing consumer loans unrealistically high, banks have been making a serious mistake, as they cannot charge a high enough loan rate that could compensate for the loss arising out of an irrecoverable loan. More importantly, if consumer finance has to pick-up as a truly helpful mechanism for spurring domestic demand, it must be ensured that it remains within the consumers' capacity to repay their loans on time, and they feel confident about taking loans again and again.

As it is, ordinary consumers' capacity to borrow and repay loans out of their savings has been rendered precarious by decades long cycle of inept economic policies that have made the poor even poorer. Low rise in per capita incomes (the impact of which was compounded by falling purchasing power due to rapid depreciation of the Rupee) caused savings to fall and poverty to rise. This combination steadily depressed consumer demand even for the less expensive consumer durable. The sustained trend of depressed demand prevented the development of a sizeable industrial base and contraction in opportunities for investment and employment. In the last two years, steady reductions in returns on savings have further diminished consumers' capacity to repay bank loans.

Banks are belatedly trying to redress this enormous macroeconomic structural imbalance but given the historic pattern of economic developments, they will be handicapped in their efforts to promote consumer finance. Signs are that while lower interest rates have certainly enhanced borrowers' capacity to borrow and service consumer loans, the newly created demand is pushing prices of consumer durable to unrealistic levels.

Taking the example of automobile, strengthening of the Rupee and substantially lower interest rates should have brought their prices down or at least served to stabilize them. Neither of these expectations was met because the sudden rise in demand created a distortion that allowed assemblers not only to push up prices but also created a roaring black market in this sector. With banks now offering liberal consumer finance facilities for acquiring home appliances, their prices too are on the rise, although there is substantial over-capacity in this sector.